AT&T Earnings Preview: Postpaid Subscriber Adds, Margins in Focus

AT&T is scheduled to announce its Q2 2014 results on Wednesday, July 23. The carrier reported a strong set of results last quarter as it successfully fended off competition from rivals such as T-Mobile to post its best Q1 subscriber growth in five years. The second largest wireless carrier in the U.S. added 625,000 postpaid subscribers in Q1, more than double the figure from a year ago. Its overall revenues grew year-on-year by 3.6%, partially aided by the acquisition of Leap Wireless during the quarter. The carrier’s strategy to combat T-Mobile’s ‘Uncarrier’ initiatives with equipment financing plans of its own worked well, as Next accounted for 40% of its postpaid smartphone gross adds and upgrades in Q1 – up from 15% in the previous quarter.

When the company announces its second quarter earnings, we expect revenues to grow in the low-to-mid single digits, owing to robust wireless postpaid subscriber adds, an expanding U-verse user base and its continued focus on margins. In a recent press release, the carrier said that it expected over 800,000 postpaid subscriber additions in Q2, reflecting an increase of about 30% over the previous quarter and about 45% over the same period last year. The sharp rise in postpaid user adds is likely because of growing acceptance of the carrier’s Next program as well as its Mobile Share Value shared data plans.

On the cost side, we expect the carrier’s EBITDA margins in Q2 to remain flat year-over-year at 42-43% as pressure from strong sales and promotional activities offsets most of the gains due to a subscriber shift towards the no-device-subsidy model. Our $38 price estimate for AT&T is about in line with the current market price.

AT&T’s Next plans are significantly different from the traditional U.S. postpaid schemes where subscribers get subsidized smartphones in exchange for signing a two-year contract. Under the Next program, much like T-Mobile’s Uncarrier and Verizon’s Edge programs, a customer can choose to get a new smartphone every 12-18 months at minimal upfront costs and discounted monthly installments. The convenient monthly installments incentivize buyers to pay the full price of their devices, helping AT&T cut its subsidy expenses.

AT&T and T-Mobile have been more aggressive in pushing financing plans than Verizon and Sprint. While T-Mobile was the first to launch these plans in early 2013, AT&T warmed up to the idea towards the end of the year. Owing to the growing user preference for no-contract plans, AT&T’s service EBITDA margins improved 220 basis points to 45.4% in the first quarter of this year. With the company expecting 50% of its total postpaid users to be on no-device-subsidy plans by the end of Q2, compared to 25% in Q1, its margins are likely to improve further in the coming months.

However, most of the near-term margin improvement will likely be due to an accounting change for Next plans that will recognize a bigger chunk of the device revenues up front. In the more prevalent subsidy model, AT&T accounts for only the subsidized price of mobile device as revenue. For example, when a carrier subsidizes a $650 iPhone and sells it for $200 with a postpaid contract, it recognizes only $200 as device revenue and takes an upfront hit of $450.

Under the new Next plans, AT&T will recognize more of the upfront iPhone cost as immediate revenue since buyers will be paying for the devices over the duration of the contracts, and the devices aren’t being ‘subsidized’ in the traditional sense. However, this revenue recognition will not translate into higher cash flows in the near term, as buyers usually pay nothing upfront and only trade in old devices to avail the Next financing plans. Therefore, while margins might improve a bit, Next could actually pressure AT&T’s cash flows in the near term by tying up working capital in financing installment plans.

Impact of Pricing Strategies on ARPU

Last quarter, over 65% of AT&T’s net adds came from connected devices (other than smartphones). Although service plans for these data-only connected devices have higher margins, they generate lower ARPUs (average revenue per user) than smartphones. Still, given that such connected devices are usually not the primary source of data consumption for most users and are mostly purchased as add-ons to an existing smartphone account, increasing adoption of these devices should help AT&T generate more revenue per account.

However, the impact of increasing data usage on ARPU levels could be offset by the aggressive pricing strategies that AT&T has had to employ to hold on to market share. In the last few months, T-Mobile has come up with a revised data allocation for its postpaid plans, adding 500MB of data to its lowest two data tiers for the same price. In response, AT&T slashed the price of its 2GB Mobile Share Value plan by $15 to $65, and the price for two lines sharing the data by the same amount to $90. These changes came on the back of price cuts announced on its more expensive family data plans in February. To mitigate the impact of price cuts, AT&T will look to increase adoption of its Mobile Share plans, especially at higher data tiers, through promotions that incentivize purchases of bigger buckets of data to share across multiple devices.

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